SATISFACTION GUARANTEED OR YOUR MONEY BACK

Wednesday, April 25, 2012

Posted by Nemo Incognito on Wednesday, April 25, 2012 with 34 comments

And relax. BBVA results not the shocker disasternistas were hoping for, the cult of AAPL continues to fleece its disciples and it is looking more as though that was NOT the big one re Europe. TMM can’t help but think this has got a july 2009 feeling about it. We had the QE sugar rush from mar09 to jun09, then the market sold off because no-one believed it. But then the earnings season was good and the market ripped higher, never looking back. OK it may be a bit premature, but with all the noise subsiding and the market blaming the quiet on “waiting for the FOMC” which to be frank no one really cares about, TMM are more inclined to believe that the markets are “shagged out after a long squawk”. Whatever the reason, we will be invoking the “do not short a quiet market” rule and expecting more up drift.

Whilst it is quiet we will have a look at something we believe is about to change the world much more than any Apple iteration – the changing shape of energy supply.
TMM would like to start today’s post with an interesting chart showing energy costs per Gigajoule for major fossil fuel sources in the US. White is Power River Basin coal, orange is henry hub gas, yellow is oil and pink is international coal (Newcastle spot).

As you can see, the big story of energy prices going to the moon over the last decade remains very much intact but gas has been doing something very unusual – after spiking hard it has gone into a massive decline and is almost as cheap as powder river basin coal on a per GJ basis. The cause of this is the fracking revolution in gas production which has massively increased the US’ fossil fuel reserves. It is already being keenly felt in power markets where US coal companies are being killed by the increased competitiveness of gas fired power generation as the portion of the day in which it makes sense to burn gas is longer and more profitable, reducing those peak time margins that coal fired power plants make much of their profits from. For coal equities this is hardly news – Cliffs Natural Resources, Alphadyne and Arch Coal have not been feeling the vim and vigor of a resurgent US economy.
Similarly the US’ strategic exposure via oil imports to the Middle East and less than friendly regimes like Venezuela is waning judging by the chart below. Crude import percentage from Saudi in white, Canada in orange and Venezuela in yellow (Note the post Libya ramp in Saudi imports – that won’t be around for long).

TMM can’t help but feel that the money for the “war on terror” could have been better spent, but the US appears to have been a classic case of “better lucky than smart” in that regard since they have secured a reduced exposure to middle eastern madness through oil sands.
Now, not that oil is mattering as much as it used to – below are vehicle miles travelled in the US in orange, inferred gasoline demand in green and average MPG of sales in white.

Not hard to see what is going on here: a period of high oil
prices has pushed consumers into buying much more efficient vehicles and
vehicular travel has peaked. Much like any business if unit sales and prices
are down revenues are down a lot. TMM are wary of hockey sticks though so we
thought we would do the comparison of a new efficient hybrid, say a Prius C and
a Corolla. In summary – it’s ugly, and the google docs link is here. You need
$2 gasoline to even think twice about not buying the hybrid. In addition,
companies like Ford are offering vehicles in gasoline, electric and LPG
versions. No points for guessing how gasoline stacks up in the lifetime cost
analysis there. Simply put, the vehicle mileage hockey stick is going further,
a lot further unless WTI halves. It would be particularly disturbing if people
widely moved to plug in electric cars which essentially allow you to do what
the power grid does – determine which fuel is cheapest to burn then burn that.
In that case you would expect oil and gas to converge on a per GJ basis which
would be a catastrophe for WTI.

In summary a few very important things are happening in
energy, but particularly so in the US:

Energy prices are falling for gas, with knock on
effects for other markets in which it is substitutable. Similarly, vehicle
fleets are becoming more efficient and gasoline demand in DM is probably in a
structural bear market on that alone. This has major implications for US
inflation most of which has been from food and energy in recent years despite
motor fuel being only ~5% of CPI basket and heating and utilities being another
5%. It may be the case that even if housing recovers and “rent equivalent cost
of ownership” (~40% of the basket) stabilizes that the US has a very
benign inflationary environment for structural reasons. Buy all the gold you
want, but if people’s gas bills cease to exist or go into a nominal decline
then that will take the bite out of a lot of quantitative easing in
commodities.

The historic segmentation of the energy markets
into transport fuels and utility fuels is starting to blur and is likely to
continue to do so. For that reason, the pricing per GJ for each should converge
over time. You may not be able to make everyone in the US buy an
electric car tomorrow but the ability of
WTI to command a big premium over henry hub will weaken over time.

US energy imports are falling fast and will
continue to do so as the vehicle fleet turns over. This is going to have major
implications for US defense spending – how much does the US care about the Middle
East, ex oil? TMM would note that if the straits of Hormuz are
closed, China has more to
lose from it than the US.
In addition, it has major implications for US tax receipts if people buy LPG
cars or electric ones. US utilities pay cash taxes in the US, Saudi
Aramco does not. The major problem of
the US
from a macro standpoint, its twin deficits and high debt may be reduced
materially by these trends and the historically cheap USD may be the best buy
in FX for the next decade.

Make it in America? The US and particularly
the Democrats have developed some kind of romantic attachment to manufacturing
and politically astute CEOs like Andrew Liveris of Dow have picked up on this
theme and have called for the US to have an industrial policy, aka, handouts
for corporate along the lines of China. TMM see this for what it is – getting
something for nothing and think it is largely unnecessary for most businesses.
It is highly unlikely the US
is going back to making garments or in any way competing with the scale
efficiencies of southern China
when it comes to cheap labor, especially as China’s factories increasingly
replace labor with capital. Where it can compete however is in areas that
are skills or technology intensive (when in doubt, buy out Asia’s
best and brightest with grants) and anything that is energy cost intensive.
Liveris notes that labor is <12% of COGS at Dow and Energy is 25% or more.
TMM think that $2 gas makes a much bigger difference than looser labor laws or
tax holidays.

The Downside….

There is another side to all this aside form extolling the
virtues or hope of a resurgent America,
and that is the effect it will have on those on the long side of the
commodities trade. For the likes of the Middle East
and Russia TMM have this to say:

Saudi and Russia
in particular have developed fiscal arrangements (Saudi’s covered well here) such
that their economies “don’t work” at much less than $90 WTI. Russia is not that
much better and is more dependent upon gas, something that the European buyers
they have held to ransom for so long might not want to buy if they can frack
their own as Romania
is currently exploring. For that reason TMM are hard pressed to think of currencies
they dislike more than the rouble – all the terms of trade frothiness of Australia with
a boatload of political risk and a much bigger credit bubble as can be seen
below.

Even in the case of Australia all those lazy RBA terms of
trade and commodity price projections may go awry if China manages to produce a
lot of fracked gas – China SOEs have never been ones to shy away from
renegotiating off take of commodities if it suits them though that is likely a
late 2010s / early 2020s problem. Some countries have the political wherewithal
to take such a crunch in terms of trade (Brazil,
Australia)
others might not make it and require some institutional change when they can’t
deliver their side of the autocracy / milk-and-honey trade.

Of course the real crunch
comes against renewables. Whilst cost differentials have been narrowing between
traditional fossil fuels and solar and wind,. will the energy addicts be able to resist dirt
cheap carbon emitting gas for the benefit of the environment? TMM think not as
austerity drives people to short term survivalist individualism rather than
long term community spirit though that is arguably in the price these days. The larger shock is that by the time we start running out of gas energy prices might be following solar's quasi Moore's law - which wouldn't hurt any of TMM's power bills.

Watched a doco not long ago about Fracking, nothing good was depicted..just one court case after another in the USA where regional communities we"re ( and some succeeded)in trying damn hard to kill off hydraulic fracturing projects.Showed some case studies, not good.

Moreover, it gave the impression that projects like this we're popping up like brown shoots in the EZ...no doubt we'll hear more.

ps...Amplitudeinthehouse says,thanks for the some original brain teasing, it's not often he gets away from the mind numbing extrapolation that feeds into the local community that he is currently surrounded by, be it from movies, movie adaptions from novels, cartoons,local newspapers and any written bio ( preference to those formely guest of HM). many thanks.

Fracking good post, Nemo. The problem with natty in the US is that (as usual) the infrastructure isn't worth shit. [e.g. Our trains and rail stations look like they did in the 1950s.] There are hardly any CNG filling stations over here, although some of the vehicle fleets and regional buses have converted.

So, among the reasons Natty is so incredibly cheap in the US are:

a) we have got a lot of it, b) we are producing a ton of it, c) we didn't burn much this mild winterd) we are running out of places to store it and e) we mainly use it to run our barbecues

A change in gasoline tax policies would start the ball rolling in the right direction. With UK style petrol taxes we would all be driving LPG vehicles already. But with US politicians still bent on fellating the oil industry we will be waiting a while.

Welcome back, Nemo. LB assumes that the remainder of TMM are hung over after Boozy Tuesday and perhaps might be Chelsea fans still coming to terms with the smash and grab job pulled off overnight in Cataluña? Amazing game.

Despite the economic sense of fracking and what will probably become an eventual acceptance - it makes too much sense not to, in the near term it depends as much on politics as anything else. A very sensitive issue already, as one of your earlier, since removed comments alluded too. Of course those are issues for another blog, but one has to be well aware of the risks from an investment standpoint. As an example the pass through status that MLPs currently enjoy may go the way of the Canadian Royalty trusts if el presidente gets his way. Lots of unknowns in an election yr. As for the rest, lets just say I'm feeling Blue.

We are clearly back in the world of central bank arb, where weak US economic data releases increase the perceived probability of further easing, and supports USTs and equities. As long as this dynamic stays in play, all those strong dollar/vigorous US recovery trades are not gonna work. US Q1 GDP tomorrow may do nothing but cement this tendency.

Folks for clarification I am talking about hybrids here which now, in Prius C format are silly cheap.

Plugins are still pricey and fwiw I think we'll see the high end of the market (think Tesla) go electric and the plug in side will be neither here nor there. I think its an intermediate step which is as necessary as the laser disc (Remember those LP sized DVDs?). But nonetheless if you have people buying a Prius C over a fiesta or a corolla that is huge and will righteously trash the market.

If you want to do a Prius C versus corolla set all driving to gas and use the mileage number. only need the power input if you are charging up at home. I've done side by sides for a bunch of price points and cars and I think Tesla is right.... luxury end will switch before the punters though mileage is ripping there too.

This was a post about tracking and how electrically powered cars were going to enforce the GJ arbitrage between liquid fuel and electrical generation.

And now you say "set all driving to gas" ?

BTW, it has been ages that the european middle class drive 50+ MPG compact diesel cars, and I didn't really see the trashing of the oil market.

Barring some revolutionary development in battery technology, american cars improvement in MPG (which will be merely a catch-up to european standards) will just leave some fuel on the table so that the chinese can drive their cars (and as they don't have a lot of money, they will go for the cheap high MPG no hybrid fancy car).

I don't see oil at 50$ on a sustained long term basis because long hydrocarbon molecules are really a very efficient way to solve the problem of mobile energy storage. At a 4 or 5$ price point, there is potential for various synfuel scheme to take over from dwindling natural supplies.

This being said, the trump card is the price of greenhouse gases release. If at zero, synfuel from NG and coal will thrive ; if not, batteries may have a fighting chance but still could still be ultimately defeated by climate friendly synfuel processes (when Saudi energy minister talk about atmospheric carbon capture in their speeches, I don't think it is to put the CO2 into the ground, they probably have more in mind to turn it back to fuel using solar or nukes)

USDJPY still executing a retrace of the huge move off the all time low at the end of January. Expect something in the 78s-79s again (a 50.0-61.8% Fib retrace) on renewed USD weakness, before BoJ acts again some time this summer?

Big moves today in the most crowded trades.... AUD in particular and a decent run of AUDCAD. While TMM like the "long dollar" stuff we do trade it.... shorting a non-existent China fraud this ain't. No heroes in macro etc.

And on Spain, quite. TMM were discussing recently that you basically need to put a few of the crappy caixa idiota types under to show them cold steel while leaning on a deposit guarantee. The strong ones are already buying back their covered bonds. Bifurcation? TMM's more educated friends in financials think so.

As for rest of Ibex you have to wonder how much lower Telefonica can go. Stub value of the spanish biz is a 2.5x EV/EBITDA proposition once you strip out Latam and that is circa SK Tel in 2002 type valuation territory - normally a huge lift.

TMM, one other aspect to the US energy equation you forgot: US domestic oil production. It has recently reached levels not seen since around 2000, and it is headed higher. Current production is around 6.1 million barrels/day, and it is easily going to 7 million barrels/day within the next 2-3 years or so. Eight million barrels/day is not out of the question either, and some are beginning to speculate it could match its 1970 high sometime within the next 10 years.

Unkown - you are right. Shale gas often comes with some liquids which has led to a big increase in oil production. TMM aren't sure that is as long term a trend as gas but it sure is helping in the interim.

While I agree the ruble is good to short, the short is not that obvious as the rather manipulative Russian credit to gdp graph implies, with taking 96 as the base where, Russia didn't have a financial sector at all.

Russia's sov debt to gdp is 10% and private companies (many of them quasi sov) are around 100%, consumer credit is around 10-20%.

Considering the above, don't see much sense in presenting the data in the format you did, as one could start thinking Russia is heavily overleveraged in contrast to peers, while in reality it has still one of the lowest credit to gdp ratios